Unit 1: Concept & mechanism of income tax
Income Tax Law & Practice notes · PTU syllabus (BCOM 403-18)
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Unit summary
Income tax is India's most important direct tax. This unit covers the basic concepts and definitions of the Income-tax Act — income, person, assessee, previous year and assessment year — the distinction between capital and revenue, residential status, the basis of charge and scope of total income, and incomes that do not form part of total income.
After this unit you can
- Explain key definitions — income, person, assessee, previous year and assessment year
- Distinguish capital and revenue receipts and expenditure
- Determine residential status and the scope of total income
- Identify incomes exempt under Section 10
PTU syllabus topics
- Definitions
- concept of income
- previous year and assessment year
- distinction between capital and revenue
- residential status
- basis of charge and scope of total income
- incomes not forming part of total income
- 1Income under five heads
Salary, house property, business, capital gains, other sources
- 2Gross total income
Add all heads after set-off
- 3Deductions
Allowable deductions
- 4Total income
Taxable income
- 5Tax
Apply slab rates, then rebate and cess
Topic 1
Concept and mechanism of income tax
- Governing law: Income-tax Act, 1961 (replaced by the Income-tax Act, 2025 from 1 April 2026, which uses the term "tax year" and renumbers sections); annual Finance Act (rates); Income-tax Rules, 1962; CBDT circulars. These notes use the 1961 section numbers followed by the syllabus and most textbooks.
- Article 265: no tax without authority of law; income tax (other than on agricultural income) is in the Union List (Entry 82).
- 1
Determine residential status
- 2
Classify income under five heads
- 3
Compute income under each head
- 4
Clubbing and set-off of losses
- 5
Gross total income
- 6
Less Chapter VI-A deductions
- 7
Total income (rounded to nearest ₹10)
- 8
Compute tax at applicable rates
- 9
Less rebate, add surcharge and 4% health and education cess
- 10
Less TDS, TCS and advance tax
- 11
Tax payable or refund
Important definitions
- Income (Section 2(24)): inclusive definition — profits and gains, dividends, voluntary contributions to trusts, perquisites, capital gains, winnings from lotteries, gifts above limits, etc. Income includes illegal income; a receipt from a source is income, a windfall may be casual income.
- Person (Section 2(31)): individual, HUF, company, firm (including LLP), AOP/BOI, local authority, artificial juridical person.
- Assessee (Section 2(7)): a person by whom tax is payable; includes deemed assessee and assessee in default.
- Previous year (Section 3): the financial year (1 April – 31 March) in which income is earned; assessment year (Section 2(9)) — the 12 months starting 1 April following the previous year.
- Exceptions where income of the PY is taxed in the same year: non-residents' shipping business, persons leaving India permanently, AOP formed for a particular event, persons likely to transfer property to avoid tax, discontinued business.
Topic 2
Capital vs revenue
Receipts
Sale of fixed assets, loans, compensation for loss of a source of income
Sale of stock-in-trade, interest, rent, commission
Taxability
Generally exempt unless specifically taxed (capital gains)
Taxable
Expenditure
Acquiring or improving fixed assets — enduring benefit
Day-to-day running — benefit within the year
Allowability
Not deductible (except via depreciation)
Deductible if for business
Example
Compensation for termination of an agency that was the assessee's main business is a capital receipt; compensation for termination of one of many agencies in the ordinary course is a revenue receipt.
Topic 3
Residential status (Section 6)
Individual
Resident — basic conditions (any one)
182 days or more in India in the PY; or 60 days in the PY and 365 days in the 4 preceding years
ROR
Resident satisfying both additional conditions
RNOR
Non-resident in 9 of 10 preceding years, or in India 729 days or less in 7 preceding years (or other special cases)
Non-resident
Satisfies neither basic condition
- The 60-day condition becomes 182 days for an Indian citizen leaving for employment abroad and for Indian citizens/PIOs visiting India (120 days if Indian income exceeds ₹15 lakh, then RNOR).
- Deemed resident (Section 6(1A)): an Indian citizen with Indian income over ₹15 lakh not liable to tax in any other country — treated as RNOR.
HUF, firm and company
- HUF/firm/AOP: resident unless control and management are wholly outside India; an HUF is ROR if the Karta satisfies the additional conditions.
- Company: resident if it is an Indian company or its Place of Effective Management (POEM) is in India.
Topic 4
Basis of charge and scope of total income (Sections 4 and 5)
| Income | ROR | RNOR | NR |
|---|---|---|---|
| Received or deemed received in India | Taxable | Taxable | Taxable |
| Accrues or arises (or deemed to) in India | Taxable | Taxable | Taxable |
| Accrues outside India from a business controlled in or profession set up in India | Taxable | Taxable | Not taxable |
| Accrues and received outside India from other sources | Taxable | Not taxable | Not taxable |
| Past untaxed foreign income brought into India | Not taxable | Not taxable | Not taxable |
- Deemed to accrue in India (Section 9): business connection, property or asset in India, salary for services rendered in India, interest, royalty and fees for technical services paid by residents, dividend by an Indian company.
Example
Mr A (NR) earns ₹5 lakh salary for work in Dubai (received in Dubai), ₹2 lakh rent from a house in Ludhiana and ₹1 lakh interest on a Dubai bank account. Taxable in India: only the ₹2 lakh rent (accrues in India).
Topic 5
Incomes not forming part of total income (Section 10)
| Section | Exempt income |
|---|---|
| 10(1) | Agricultural income (used for rate purposes — partial integration) |
| 10(2) | Amount received by a member from HUF income |
| 10(2A) | Share of profit from a firm |
| 10(5) | Leave travel concession (within limits, old regime) |
| 10(10) | Gratuity (limits; ₹20 lakh for non-government employees) |
| 10(10A) | Commuted pension (limits) |
| 10(10AA) | Leave encashment on retirement (₹25 lakh limit for non-government) |
| 10(10D) | Life insurance maturity sums (subject to premium conditions) |
| 10(11), 10(11A) | Interest on PPF, Sukanya Samriddhi |
| 10(13A) | House rent allowance (old regime) |
| 10(14) | Special allowances (conveyance, uniform, children's education) within limits |
| 10(16) | Scholarships |
| 10(23C), 11 | Income of educational and charitable institutions (conditions) |
- Agricultural income (Section 2(1A)): rent or revenue from agricultural land in India, income from agricultural operations, income from farm buildings. Partial integration applies for individuals/HUFs when agricultural income exceeds ₹5,000 and non-agricultural income exceeds the basic exemption limit.
Exam tip
Always state the section number with exempt incomes — it is the quickest way to show precision.
Key terms
- Previous year
- Financial year in which income is earned
- Assessment year
- Year in which income of the previous year is assessed
- Assessee
- Person by whom tax or any sum is payable under the Act
- Residential status
- Determines the scope of income taxable in India
- Exempt income
- Income not included in total income under Section 10
Quick revision
- Income includes illegal income; person has seven categories.
- PY income taxed in the AY, with exceptions.
- Capital receipts generally exempt; revenue receipts taxable.
- Individual: 182 days or 60 + 365 days; ROR/RNOR/NR; company — Indian or POEM.
- Section 10 exemptions — agricultural income, firm share, gratuity, PPF interest.
Important exam questions
Practice questions written to the PTU exam pattern for this unit's syllabus: short answers (Section A style) and long answers (Sections B and C style).
Short-answer questions
- Q1.Define "person" under the Income-tax Act.
- Q2.What is the previous year?
- Q3.Distinguish capital and revenue receipts.
- Q4.What are the basic conditions for a resident individual?
- Q5.What is POEM?
- Q6.Name any four exempt incomes under Section 10.
Long-answer questions
- Q1.Explain the basic concepts and the mechanism of computing income tax.
- Q2.Explain the distinction between capital and revenue receipts and expenditure with examples.
- Q3.Explain how the residential status of an individual and a company is determined.
- Q4.Explain the incidence of tax based on residential status with an illustration.
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